Capital Markets

Lehman Brothers on Life Support

Credit default swaps calculate there’s a 35-40 percent chance the investment bank will default in the next five years.
Stephen TaubSeptember 12, 2008

When credit default swaps speak, investors listen.

This is once again being played out, this time at the headquarters of Lehman Brothers Holdings, where the question is not whether, but when, the oldest investment bank will be sold or left to wither and die.

The betting among the pundits is that its fate will be sealed one way or the other by the end of the weekend.

Credit derivative traders currently are betting there is a more than 20 percent chance Lehman will default on its debt in the coming year based on the level of its credit default swaps. Five-year credit default swaps on Lehman imply that there is a 35 percent to 40 percent chance the bank will default in the next five years, according to Reuters.

Lehman’s plight is no anomaly. The Baird CDS Index suggests the seizure that has gripped the credit markets for more than a year now appears to be tighter than ever. For example, on August 31, the index closed at a new record after increasing three months in a row and setting consecutive record monthly highs.

The index now stands 7.8 percent above its level on February 29, just before the Fed moved to ease the credit crisis and prevent the total collapse of Bear Stearns. “It is also up by 36.9 percent from its level on May 31, when many observers incorrectly surmised that the worst of the credit crisis had passed,” says Robert W. Baird & Co.

“Baird’s most recent data indicates that the dog days of summer continued during August as far as liquidity available to non-investment grade borrowers, with the price of credit risk insurance continuing its three-month surge, closing at another all-time high last month,” Baird noted in its most recent report.